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Claire's Stores Struggles With the Low End

Customers are pushing the company known for selling accessories on the cheap further down the price spectrum.

There is no better way to explain what's going on at Claire's Stores(NYSE:CLE) than to pull a quote from Co-Chairman and Co-CEO Marla Schaefer in the company's third-quarter earnings release.

Over the past four years, we have created a robust jewelry business as increasing levels of consumer demand for fashion jewelry drove sales. While current trends continue to emphasize fashion jewelry, our customers are moving towards simpler, more streamlined looks and value-priced items. Additionally, there is renewed interest in our accessory offerings, which are, for the most part, lower-margin products.

Claire's has been fairly successful at increasing its margins the last few years, which can be seen in its gross margins. They've increased to 54.3% for fiscal 2006, from 48.4% in fiscal 2002. Some fallback in margins isn't a total surprise after such a strong and steady rise. But considering the overall low pricing of the merchandise, I find the quote interesting, and it'll be important to follow how the company manages this trend.

Our Fool by Numbers highlights that margins are down across the board and the somewhat slow 6% sales growth. They're exactly what I would expect to see from a company discussing how its customers are buying lower-priced products.

In some respects, it's not entirely fair to ding the company for its financial performance. Claire's certainly did not do well, but last year's results were very good, and while this year's results didn't follow suit, the company isn't about to fall apart, either. Same-store sales, for example, were flat overall, though they were down slightly in Europe and at the company's icing brand. By comparison, last year's same-store sales were up 9%.

Claire's continues to maintain a strong balance sheet. The cash balance is down about one-third from where it was at this time last year, but the share count is also down 5%, because the company completed its $200 million buyback of 7.1 million shares. Historically, Claire's has had strong cash flow as well. Judging by the movements in the company's working capital, reported depreciation, and store expansion numbers, I expect that when the company files its 10-Q with the SEC, its cash flow results will remain strong and in the same ballpark as historical results.

Claire's is struggling a bit, but the stock isn't expensive, and the company lacks any focused competitors. Yes, retailers such as Target(NYSE:TGT), Limited Too(NYSE:TOO), and TweenBrands(NYSE:TWB) may all sell some similar accessories, but none have the variety and turnover in their offerings that Claire's has. Considering how basic Claire's business is, its uniqueness and position are fairly impressive, and its inventory and balance sheet management are impressive as well. For those reasons, it's a company to latch onto if shares get unreasonably cheap.

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